We’re All Wrong About Bitcoin. It is not deflationary. | Hacker Noon

June 18th 2020

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It is true that there is a reduction in the new supply of Bitcoin due to the halving, but this does not mean that Bitcoin is a deflationary asset.

In several bitcoin reports (here, here and here), there is a general consensus that Bitcoin is deemed a deflationary asset.

That is not correct.

Short answer: We talk about Bitcoin inflation as monetary inflation while we talk about FED and global economy as price inflation. These are different measures, so you cannot cross reference it that way.

Long answer

Watch the video below:

What is Monetary Inflation?

Monetary inflation is the increase in the money supply. Depending on the factors, this can result in price inflation or “inflation” that you read on the news. However, as highlighted earlier, the result in price inflation is not always the case.

What is Price Inflation?

Price inflation, on the other hand, is what the measure is referred to when you read the newspaper. It is also one of the mandates by the central bank when it comes to adjusting the monetary policy.

Price inflation is the increase in the general price level of goods and services.

Thus, monetary inflation and price inflation are different. The only link between them is that we use money (affected by monetary inflation) to purchase goods and services (affected by price inflation).

Wrong Statement

The wrong statement is saying that Bitcoin is deflationary because the monetary inflation of Bitcoin is now lower than the FED’s targeted inflation growth of 2%. That is wrong because these are 2 different measures and you cannot compare them like this.

In fact, there is a low correlation between monetary inflation and price inflation, as seen in 2008. In 2008, we have the global financial crisis, and the FED reduced the reserve rates in hopes to boost liquidity and hence money supply.

Theoretically, this can result in price inflation since there is more money available. However, we did not see price inflation in daily goods and services. Thus, there is no strict correlation between monetary inflation and price inflation.

Hence, it is wrong to say that because bitcoin’s monetary inflation is lower than the FED’s target of 2% inflation, that means bitcoin is a deflationary asset.

However, do note that there is a general consensus by economists believing that a massive increase in money supply causes hyperinflation. This is more of a tail-end situation, hence it should not be taken as a general phenomenon of the relationship between money supply and price inflation.

What about Bitcoin?

Firstly, Bitcoin is currently experiencing monetary disinflation. Disinflation is a slow-down in the inflation rate. Bitcoin is still increasing its supply even with the halving of block rewards. The increase in supply is just less every four years, hence disinflation is the right term.

Secondly, deflation is a decrease in the general price level of goods and services, the opposite of inflation. That means price inflation rates are negative. It does not mean that the change in the inflation rate is negative.

How to determine whether Bitcoin is truly deflationary?

To compare Bitcoin’s economy and the US economy, we have based them on price inflation. As prices of goods and services are not exactly priced in Bitcoins, it is tricky to measure the price inflation of Bitcoin.

Traditionally, price inflation is determined by 2 indexes:

  • Consumer Price Index (CPI)
  • Personal Consumption Expenditures price index (PCE)

These are similar indexes to measure price inflation, however, they do have their differences.

To measure if Bitcoin is truly deflationary, we have to start calculating the CPI or PCE of a basket of goods in Bitcoin and compare it across a time variable.

I’m keen to research more on this topic to get a better
quantitative measure of the price inflation rate of Bitcoin. Please
contact me via LinkedIn if you have some data on this or are keen to explore this area!
For more of such content, check out the weekly podcast and Youtube series on the economics of token ecosystems.

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